FM-AA-CIA-15 Rev.

0 10-July-2020

Study Guide in (Course Code and Course Title) Module No._3_

SSE 107 - Macroeconomics

STUDY GUIDE FOR MODULE NO. 3

An Overview of the Economy

MODULE OVERVIEW

Module Outline
A. The Circular Flow of Output and Income
B. The Multiplier Effect and the Circular Flow
C. Inflows and Outflows

Introduction
This particular module stresses the interaction between the households and firms as regards production,
consumption, employment and income generation resulting to the circular flow of goods and services in the
economy. Spending that goes into the economic stream is likewise discussed considering that it may generate
an income higher than the original inflow which explains further its effect on the level of economic activity.

MODULE LEARNING OBJECTIVES

At the end of the module, students are expected to:

1. explain the circular flow of economic activity with particular stress on the roles played by the different
sectors involved in the flow;
2. discuss the concept of multiplier effect and how it relates to the circular flow; and
3. explain the effects of excess in inflows over outflows in the level of economic activity.

LEARNING CONTENTS (title of the subsection)

The Circular Flow of Economic Activity

Within the economy, the basic activities of production, consumption, employment and income
generation take place through the interrelationship existing between the basic consuming unit, which is the
household and the basic producing unit, which is the firm.
The business firm supplies the household with goods and services in exchange for payments
representing consumption expenditures. On the other hand, the business firm has to use economic resources
consisting of land, labor, capital and entrepreneur to produce these goods and services. The household
provides the firms these resources in exchange for payments in the forms of rent, interest, wages/salaries and
profits.

Fig. 1 – The Circular Flow of Goods and Money Income

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Study Guide in (Course Code and Course Title) Module No._3_

The circular flow also shows the flow of money and the flow of goods and services in both directions.
The financial flow, which is the money flow, is depicted in the money payment by the firm to the household of
its money income, and by the household to the firm for its purchase of goods and services. On the other hand,
the physical flow, which is the goods flow, is depicted in the flow of economic resources from the household to
the firm and in the flow of goods and services from the firm to the household.

The Circular Flow of Output and Income

The value of all commodities produced in the economy during a year is equal to the amount (money)
which business firms spent and which households as resource owners received; hence, the two flows of
output and income are exactly equal. Within the circular flow, the measure of output and the measure of
income always result in the same value.

Fig. 2 - The Circular Flow of Income

Implications of the Circular Flow of Economic Activity

1. The goods, resources, and money payments will flow as long as households continue to consume, and as
long as firms continue to produce.
2. That since goods and resources flow in exchange for payments, the rate of payments flow will in the end
be the same. Money is the inducing factor, and the pillar of the price system. Without it, there is no price
system.

The Multiplier Effect and the Circular Flow

The multiplier effect is a number that determines the increase in income as a result of a given amount
of spending in the economy. This is an effect in economics in which an increase in
spending produces an increase in national income and consumption greater than the initial amount spent.

For example, if a corporation builds a factory, it will employ construction
workers and their suppliers as
well as those who work in the factory. Indirectly, the new factory will stimulate employment in laundries,
restaurants and service industries in the factory’s vicinity. The multiplier in effect increases the resulting
income depending on the consumption behaviour of the people.

Inflows and Outflows

Inflows are the factors that increase the level of economic activity, while outflows decrease the level of
economic activity.
Inflows include investment, government spending and exports. Outflows on the other hand include
savings, taxes, and imports.
A desire to change the level of economic activity in the flow may lead to the manipulation of a country’s
inflows and outflows. Outflows are difficult to control because they are dependent on income. When income
increases, we expect savings, taxes, and imports to increase. Inflows are easier to manipulate. The proper
use of policy enables the government to encourage exports and investments and to increase its expenditures
when it desires to expand the flow of economic activity.

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Study Guide in (Course Code and Course Title) Module No._3_

Fig. 3 - The Circular Flow of Economic Activity Reflecting the Outflows and the Inflows

LEARNING ACTIVITY 1

Direction: Make a brief explanation of the diagram stressing the roles of the government and foreign
countries in the circular flow.

Fig. 4 - The Circular Flow of Goods and Income of Household and Firms,
With the Government and Foreign Countries

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Study Guide in (Course Code and Course Title) Module No._3_

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SUMMARY

Within the economy, the basic activities of production, consumption, employment and income generation
take place through the interrelationship existing between the basic consuming unit, which is the household
and the basic producing unit, which is the firm.

The circular flow of economic activity covers the production process, exchanges of commodities, income
between households and firms and between firms, and exchanges between firms, households, the
government and foreign countries.

When money spent multiplies as it filters through the economy, it is called multiplier effect. Money spent
in the economy doesn't stop with the first transaction. Because people spend most of the extra income they
get, money flows through the economy one person at a time, like a ripple effect when a rock gets thrown into
the water. 

REFERENCES

A. BOOKS

Azarcon, Ernie Roy S. et al.(2005). Principles of Economics with Taxation and A.R. Baguio City. Valencia
Educational Supply.

De Guzman, Rachele D., et al. (2013). General Economics, Taxation and Agrarian Reform. Meycuayan City,
Bulacan. IPM Publishing.

Medina, Roberto G. (2003). Principles of Economics. Manila. Rex Book Store.

Miranda, Gregorio S. Introductory Economics. (2001). L and G. Business House.

Omas-as, Roberta L. (2008). Introductory Economics. Q.C.: Great Books Publishing.

Pagoso, Cristobal M. et al. (1996) Introductory Economics. Manila: Rex Book Store.

B. ONLINE SOURCES

https://www.economicsdiscussion.net/circular-flow/the-circular-flow-of-economic-activity/18159

https://study.com/academy/lesson/circular-flow-of-economic-activity-the-flow-of-goods-services-
resources.html

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